The Bank of England has ordered a review of prime brokerage businesses at UK banks in the wake of the Archegos family office scandal and said senior executive pay should be cut if they fail to address problems.
The announcement is part of a co-ordinated international regulatory effort to avoid a repeat of the risk management failings that led to losses of more than $10bn from the collapse of family office Archegos.
In a letter to UK bank chief executives, the BoE said its analysis of the circumstances of the Archegos failure had found “significant cross-firm deficiencies” in the way bank prime brokerage businesses allowed the fund to build up huge loans that it ultimately defaulted on.
A handful of global banks that had Archegos as a prime broking client lost a total of $10bn when the family office, run by former Tiger Global hedge fund manager Bill Hwang, collapsed in March.
Credit Suisse, which lost $5.5bn, has since all but exited prime broking, while Nomura, which was left with $2.9bn of losses, has also pulled back.
Prime brokerage businesses offer trading services to investment funds, including lending them money. This allows them to invest multiples of a “margin” they deposit with the bank in everything from equities to complex derivatives.
Failings identified by the BoE included prime brokerage business plans that “lacked coherence, were opportunistic, or otherwise had not been rigorously assessed or challenged by senior management” and “little or no follow-through from the initial reputational risk assessment (on particular clients) into ongoing risk appetite calibration for an account”.
Banks were also criticised for “ineffective and inconsistent” approaches to how much money they loaned their prime broking clients, and for not requiring “routine disclosure of the wider financing relationships and investment exposures of their hedge fund and family office clients”.
“It is highly concerning that lessons from the Global Financial Crisis have not been learned sufficiently and that necessary changes to business and risk management practices have not been embedded in firms’ operations,” the BoE wrote.
UK-based banks must now carry out a systemic review, the BOE said, covering everything from their prime brokerage business strategy to how they took on customers and decide how much money to lend them, a process known as margining.
They must present the results, with “detailed plans for remediation” of any problems found, to the BoE and the Financial Conduct Authority by the end of the first quarter of next year.
“To ensure that any necessary improvements identified are made in a timely fashion, we expect you to consider reflecting progress when setting the variable remuneration of relevant senior executives,” the BoE added, regulator-speak for warning that failure to improve should have an impact on bonuses.
The US Federal Reserve simultaneously published a letter to its banks reminding them of the existing guidelines about how large banks should deal with investment funds, urging them to consider client backgrounds and openness and to keep risk limits under review.
The Fed did not mention specific shortcomings it found in its recent review, but said that generally it was concerned in situations where companies accepted “incomplete and unverified information” from funds.
It also warned of the dangers of “poor communication frameworks and inadequate risk management functions”.
A report into Archegos by law firm Paul Weiss, which was commissioned by Credit Suisse and published in July, found the losses were the result of a “fundamental failure of management and controls” in the lender’s investment bank and a “lackadaisical attitude towards risk”.
Additional reporting by Owen Walker
